The US economy shows signs of continued weakness and the Federal Reserve is prepared to lower interest rates again if growth doesn't pick up soon, Fed Chairman Alan Greenspan said.
``We aren't free of the risk that economic weakness will be greater than currently anticipated, and require further policy response,'' Greenspan told the House Financial Services Committee.
Additional rate reductions probably would be limited, he suggested, because the central bank has already cut the benchmark overnight lending rate to 3.75 percent, the lowest in seven years.
PHOTO: REUTERS
The Fed forecast the economy will expand as much as 2 percent in 2001 and more than 3 percent in 2002, as a rebound starts to take effect late this year -- boosted by six Fed interest-rate cuts and a reduction in income taxes. Using the Fed's measure of growth, the economy expanded 3.5 percent last year.
"The rate of deterioration is clearly slowing and indeed there is considerable evidence to suggest we are approaching stability at a lower level," Greenspan said.
In his February testimony to Congress, Greenspan said the economy had performed better in the first two months of the year than in late 2000 and consumer spending had held up better than expected. Even so, he said then, the slowdown had "yet to run its full course," and the economy was "on a track well below the productivity-enhanced rate of growth of its potential." Since February, central bankers have cut interest rates four times in an effort to prevent a recession. Greenspan said on Wednesday the economy was more at risk five months ago than it is now.
"Despite all the shocks that are involved in both the domestic and international economy, our economy is still doing, not well, but clearly far better given what has happened, than I would have forecast six, eight, nine months ago," he said.
US Treasury securities rose in response to expectations of lower interest rates.
The 10-year Treasury note increased 3/4 point, pushing down its yield 10 basis points to 5.10 percent, the lowest in more than three months.
Over the past six months, the Fed's policy-making Open Market Committee has cut the overnight rate by 2 3/4 percentage points.
As a result, market interest rates have fallen, the money supply is rising, and recent economic statistics "have turned from persistently negative to more mixed," Greenspan said.
Trading in federal funds futures contracts suggests investors expect a quarter-point rate cut at the Fed's Aug. 21 policy meeting.
Greenspan told Congress that inventories for most products other than telecommunications equipment are shrinking. Coupled with falling energy prices and US$300 rebate checks going out starting today to every taxpayer, that should provide the stimulus the economy needs, he said. Greenspan emphasized that consumer spending has risen this year, assisted by an increase in home equity.
If those monetary and fiscal policies don't do enough to stimulate growth, the FOMC has scope to move again because inflation is not a problem now, Greenspan said.
High energy prices, which cut business and consumer purchasing power earlier this year, are now falling, as are prices for many raw materials. Competition still prevents most businesses from raising prices, he said, and with unemployment rising, labor costs are falling.
As a result, "overall prices seem likely to be contained in the period ahead," Greenspan said.
Greenspan's comments followed by less than two hours a report from the Labor Department that consumer prices rose 0.2 percent after a 0.4 percent gain in May. The core CPI, which excludes food and energy costs, rose 0.3 percent after rising 0.1 percent the previous month. The June increase in the core rate was the biggest in three months.
Although the CPI has "picked up this year," Greenspan said, that hasn't been matched by a rise in the core personal consumption expenditure index, a measure of inflation preferred by Fed officials. "Moreover, survey readings on long term inflation expectations have remained quite stable," Greenspan said.
The flexibility that affords policy makers may be needed if the Fed's medicine doesn't take quickly, Greenspan suggested.
One continuing concern for the Fed is that "growth of investment in equipment and software has turned decidedly negative" even though the expected long-term return on investment in those products "remains high," he said.
Also, pressure on profit margins has been "unrelenting," Greenspan said, as companies have been forced to deal with unexpectedly high energy prices at a time when low unemployment was pushing up labor costs. Both problems should ease in time, he said.
Stocks declined today after AOL-Time Warner Inc's sales missed some estimates and Veritas Software Corp reduced its revenue forecast, dashing optimism that profits would show signs of rebounding. The Dow Jones Industrial Average fell 37 points, or 0.3 percent, to close at 10569.83. The NASDAQ Composite Index dropped 51 points, or 2.5 percent, to close at 2016.17.
It also isn't clear that consumer spending will hold up.
Declining or flat stock prices have reduced household wealth, and "we can expect the decline in stock market wealth that has occurred over the past year to restrain the growth of household spending," Greenspan said.
With unemployment rising -- it rose to 4.5 percent last month -- ``softer job markets could induce a further deterioration in confidence and spending intentions," he said.
Anticipating congressional criticism, Greenspan offered a strong defense of the Fed's management of the economy over the past year. While the central bank can work to control inflation, it can't eliminate boom-and-bust cycles. "There is no tool to change human nature," Greenspan said. "Too often people are prone to recurring bouts of optimism and pessimism that manifest themselves from time to time in the buildup or cessation of speculative excesses." The Fed expects the economy to grow at a 1.25 percent to 2 percent inflation-adjusted rate in 2001, and by 3 percent to 3.25 percent next year. In February, the Fed forecast the economy would grow at a 2 percent to 2.5 percent rate. The Fed's forecasts measure growth between the fourth quarter of 2000 and the fourth quarter of 2001 and reflect the "central tendency" of the central bank's five current governors and 12 district bank presidents.
The Fed expects the personal consumption expenditure price index -- an inflation measure tied to gross domestic product -- to rise by 2 percent to 2.5 percent this year and 1.75 percent to 2.5 percent in 2002. In its February forecast, the central tendency of Fed inflation forecasts was for inflation to rise 1.75 percent to 2.25 percent. Last year the PCE index rose 2.4 percent when measured from fourth quarter to fourth quarter. Last year's increase was largest since 1993.
Slower growth will push unemployment higher, the Fed said.
The jobless rate will probably rise this year to 4.75 percent to 5 percent in the fourth quarter, according to the forecast, and 4.75 percent to 5.25 percent next year. In February, the Fed's central tendency was for an unemployment rate of 4.5 percent. In the fourth quarter of last year, the unemployment rate averaged 4 percent, close to a 30-year low.
Greenspan is required to present testimony to the Senate Banking Committee in February and the House Financial Services Committee in July. He can appear voluntarily at any time and will reprise his testimony from today to the Senate committee on July 24.
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